Edited version of your written advice

Authorisation Number: 1012656400216

Ruling

Subject: Employment termination payment

Questions

1. Is the payment an employment termination payment?

2. Is any part of the payment the tax-free part of a genuine redundancy payment?

Answers

1. Yes.

2. No.

This ruling applies for the following periods:

20XX income year.

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Remuneration of an office holder is determined in accordance with specific legislation.

The legislation stipulates what is the remuneration of an office holder and how it is determined in relation to that office.

From the 200X income year to the 20XX income year, an individual held the office involved. The individual also held additional offices in connection with the office up to and until the 20XX income year.

Toward the end of the 20XX income year an election was held in respect of the office.

The individual stood for re-election to the office. However another individual was elected to the office instead.

The legislation states that payments made to former office holders are in consequence of the termination of the holding of their office.

The legislation also states when the entitlement of an office holder to receive remuneration ceases when a successor is elected in their place.

The legislation further states how a payment, in the case of involuntary retirement of an office holder, is to be determined.

A related legislation states that a former office holder shall be deemed to have retired involuntarily if their term of office expires or was not re-elected at the conclusion of their term of office.

Your client paid an involuntary payment to the office holder less than 12 months after the termination of the office.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 80-5.

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Subsection 82-130(1).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b).

Income Tax Assessment Act 1997 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Subsection 82-135(1).

Income Tax Assessment Act 1997 Section 83-175.

Income Tax Assessment Act 1997 Subsection 83-175(1).

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The involuntary payment made by your client in the 20XX income year is an employment termination payment as it was made in consequence of the termination of the individual's office and is not a payment which is excluded from being an employment termination payment.

This payment is not a genuine redundancy payment as it does not satisfy all the criteria required to be a genuine redundancy payment.

Detailed Reasoning

Employment termination payment

Section 80-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that the provisions regarding employment termination payments apply equally to those who hold (or have held) an office as to those who are (or were) employed.

An employment termination payment, where the payment is made during the life of a taxpayer, is known as a life benefit termination payment (subsection 82-130(2) of the ITAA 1997).

Section 995-1 of the ITAA 1997 states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that:

A payment is an employment termination payment if:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's employment; and

(b) it is received no later than 12 months after that termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

Paid as a consequence of the termination of employment

It should be noted that the phrase 'in consequence of' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of'.

In paragraph 5 of TR 2003/13 the Commissioner states:

… a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

As further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be:

… a causal connection between the termination and the payment, although the termination need not be the dominant cause of the payment. The question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

The phrase in consequence of termination of employment has been interpreted by the courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation¹ (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation² (McIntosh).

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination It is not my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs stated:

It was submitted that the words in consequence of import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a following on.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that both Courts views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient.

Furthermore, in Le Grand v Federal Commissioner of Taxation³ (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

In Le Grand Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicants employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the sole or dominant cause of the payment'.

The Full Federal Court in Dibb v Federal Commissioner of Taxation⁴, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP.

Paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. The termination of the payment need not be the sole or dominate cause of the payment.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

In the facts of this case, the individual was an elected office holder. During the 20XX income year the individual stood for re-election. However individual was not successful as another individual was elected as the office holder instead. As a result the individual ceased to hold an office when that individual was not re-elected to that office.

The facts state that an office holder's entitlement to remuneration ceases when a successor is elected in their place. Further, an office holder who retires involuntarily is entitled to an 'involuntary retirement payment'. The involuntary payment was paid after the individual ceased to hold the office.

As noted earlier, section 80-5 of the ITAA 1997 states that the provisions regarding employment termination payments apply equally to those who hold (or have held) an office as to those who are (or were) employed.

It is clear from the facts provided that the involuntary payment made to the individual was made 'in consequence of the termination of employment' (or in this case, holding of an office). There is a causal connection between the termination and the payment. The termination and the payment are intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition is stated under paragraph 82-130(1)(b) of the ITAA 1997. The settlement sum must be received within 12 months of the employee's termination of employment, unless the payment is covered by a determination exempting them from the 12 month rule.

As noted in the facts, the individual ceased to hold the office towards the end of the 20XX income year. Your client paid the involuntary payment less than 12 months after the individual ceased holding the office.

As the payment was made to the individual within 12 months of the individual ceasing to hold the office, the requirements of paragraph 82-130(1)(b) of the ITAA 1997 has been met.

Exclusions under section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others):

_ superannuation benefits;

_ unused annual leave or long service leave payments;

_ foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

_ the tax free part of a genuine redundancy payment or an early retirement scheme payment.

In this case, the relevant exclusion is whether the involuntary payment includes a tax free part of a genuine redundancy payment. This is examined below.

Genuine redundancy payment

A payment made to an employee is a genuine redundancy payment if it satisfies all criteria set out in section 83-175 of the ITAA 1997. This section states:

(1) A genuine redundancy payment is so much of a payment received by an employee who is dismissed from employment because the employee's position is genuinely redundant as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of dismissal.

(2) A genuine redundancy payment must satisfy the following conditions:

(a) the employee is dismissed before the earlier of the following:

(i) the day he or she turned 65;

(ii) if the employees employment would have terminated when he or she reached a particular age or completed a particular period of service the day he or she would reach the age or complete the period of service (as the case may be);

(b) if the dismissal was not at arm's length the payment does not exceed the amount that could reasonably be expected to be made if the dismissal were at arm's length;

(c) at the time of the dismissal, there was no arrangement between the employee and the employer, or between the employer and another person, to employ the employee after dismissal.

(3) However, a genuine redundancy payment does not include any part of a payment that was received by the employee in lieu of superannuation benefits to which the employee may have become entitled at the time the payment was received or at a later time.

Payments not covered

(4) A payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)).

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. Paragraph 82-135 (e) provides that the part of a genuine redundancy payment worked out under section 83-170 is not an employment termination payment.

Dismissal and redundancy

A genuine redundancy payment is defined under subsection 83-175(1) of the ITAA 1997 as a payment resulting from:

_ a dismissal; and

_ a genuine redundancy.

The Commissioner has issued Taxation Ruling TR 2009/2, titled Income Tax: genuine redundancy payments. The Ruling provides guidance on the factors to be considered in the interpretation of section 83-175 of the ITAA 1997.

Paragraph 11 of TR 2009/2 states:

There are four components within the basis genuine redundancy requirement:

_ The payment must be received in consequence of a termination.

_ The termination must involve an employee being dismissed from employment.

_ The dismissal must be caused by the redundancy of the employee's position.

_ The redundancy payment must be made genuinely because of a redundancy.

Each of the requirements will be discussed individually.

The payment is in consequence of the termination of employment

In this case, the involuntary payment was received by the individual in consequence of ceasing to hold an office. Therefore, the requirement in subsection 83-175(1) of the ITAA 1997 that the payment is in consequence of the individual's termination of employment (or office in this case) is satisfied.

Dismissal from employment

Dismissal requires a termination of employment (or office, as the case maybe) at the initiative of the employer without the consent of the employee.

In this case, the individual sought to continue holding office by seeking to be re-elected towards the end of the 20XX income year. However, as another person was elected instead, the holding of the office by the individual was terminated involuntarily. Therefore, it is accepted that a dismissal for the purposes of the ITAA 1997 has occurred. Consequently, the second requirement of a genuine redundancy has been met.

Dismissal caused by redundancy

Section 83-175 of the ITAA 1997 requires that the dismissal be caused by redundancy of the employee's position and not for some other reason. Redundancy must be the primary reason for termination of employment by way of dismissal.

At paragraphs 25 of TR 2009/2, the Commissioner makes the following comments regarding dismissal and redundancy:

An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances of the employer's operations.

In addition, paragraph 36 of TR 2009/2 states:

Under subparagraph 83-175(2)(a)(ii), a payment made at the end of a fixed period of employment cannot normally be a genuine redundancy payment.

Paragraph 284 of TR 2009/2 goes on to explain that:

It would normally be the case that someone employed on a contract for a set period could not be dismissed at the end of that period. Their employment would simply terminate because an arrangement stipulated that the employment would cease at that time.

From the above, it is clear that employment is for a specified term which expires in the event of resignation, expiry of the term of office, or the failure to be re-elected. The holding of the office by the individual was terminated when the individual failed to be re-elected. This would be akin to a person employed on a contract for a set period. In this case, the set period is the term which the employee holds office. The individual's employment simply terminated at the end of their term in office.

Accordingly, a payment made after the end of a fixed period of employment as specified under a contract of employment is not a genuine redundancy payment. Further, it is considered that a payment made as a result of the termination of employment due to the occurrence of a specified event under which the contract expires is not a genuine redundancy payment.

Therefore, the individual was not dismissed from employment as required under subsection 83-175(1) of the ITAA 1997. As a result, the third requirement that there has been a dismissal because of redundancy cannot be satisfied.

It is not necessary to examine if the remaining criteria set out under section 83-175 of the ITAA 1997 have been met. The failure of one criterion is sufficient to exclude the payment from being treated as a genuine redundancy payment and accorded the concessional taxation treatment under section 83-175.

Conclusion

A payment made to an employee is a genuine redundancy payment if it satisfies all criteria set out in section 83-175 of the ITAA 1997. As subsection 82-175(1) has not been satisfied, the payment is not a genuine redundancy payment.

¹ (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45.

² (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325.

³ [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39.

⁴ [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786.